Cost and Pricing

The National Defense Authorization Act for Fiscal Year 2018 amended the Truth in Negotiations Act’s cost or pricing data report threshold, effective July 1, 2018, for all Department of Defense (DoD) procurement contracts, if no exceptions apply. The TINA amendment raises the threshold for submitting certified cost or pricing data (i.e., that the data are current, accurate and complete) from negotiated contracts valued at $750,000 or more to negotiated contracts valued at $2 million or more. The amendment applies to both prime contractors and subcontractors for a prime contract or subcontract entered into or modified after June 30, 2018. The threshold for submitting certified cost or pricing data threshold on preexisting contracts remains at the $750,000 level.

Congress’ purpose in raising the TINA threshold is to incentivize more and smaller companies to participate in DoD programs by alleviating some of the burden of complying with the often complex and difficult job of preparing and submitting certified cost or pricing data. Some observers have viewed these considerations as a potential chilling factor in a contractor’s decision to enter negotiated procurements where certified cost or pricing data may be required. The DoD budget for this year is already immense and its budget proposal for 2019 is also significantly more robust than in prior years. With DoD now doing more than ever, a pattern which we can expect to continue for the foreseeable future, the government will need more contractors to support its missions around the world.

However, with opportunity comes risk and it is no different here. Compliance with certified cost or pricing data requirements can be difficult for contractors, given the burden of not only preparing them initially but also monitoring the data to ensure that they remain current, accurate and complete over time if there are modifications or other changes during contract performance that are valued at or more than $2 million that may also require the submission of certified cost or pricing data. This burden also translates into risk for contractors because an erroneous certification of cost or pricing data can result in government deductions/payment withholding and breach of contract claims or even raise the specter of administrative sanctions and False Claims Act liability. These issues can present a potential minefield for contractors that have not traditionally worked on negotiated procurements, which require the submission of certified cost or pricing data and may, therefore, warrant some diligence to scope out any potential issues before deciding to submit such bids. It is also noteworthy that although the TINA threshold has been raised to $2 million, many applicable contracts will exceed that amount and even a contract that initially was below $2 million may, over time, be increased (through modifications or other means) to or above $2 million, thus potentially triggering certified cost or pricing data requirements that did not originally exist. Given these issues, contractors new to certified cost or pricing data requirements should carefully weigh these considerations before engaging in such procurements.

In its annual report to Congress, the Defense Contract Audit Agency (“DCAA”) released impressive metrics about its progress during the 2017 fiscal year. For many years, DCAA has struggled to manage a substantial number of backlogged incurred cost audits—most of which extended back several years, including some which extended back almost a decade. However, according to DCAA’s March 31, 2018 report to Congress (which was recently made available to the public), DCAA examined $281 billion in contract costs, identified $7.1 billion in audit exceptions, and reported $3.5 billion in net savings, all of which produced a return on taxpayer investment of approximately $5.20 to $1. Notably, DCAA advised that it had only 2,860 incurred cost audits in backlog at the close of 2017 and that DCAA expected to clear this inventory in 2018. While DCAA does not consider an audit to be backlogged until the submission has been pending for two or more years, the reported statistics mark a significant milestone for the agency. Indeed, going forward, DCAA advised that it expects to be fully compliant with Congress’s mandate in the 2018 National Defense Authorization Act (“NDAA”) that DCAA’s audit backlog inventory must not exceed one year.

DCAA’s 2018 annual report paints a far different landscape than those in DCAA’s prior reports to Congress. For example, in 2011, at the height of the audit backlog, DCAA had over 21,000 open audits in incurred cost submissions alone and immediate, subsequent years did not meaningfully reduce that caseload. Accordingly, just a short time ago, DCAA had nearly 10 times the number of open incurred cost audits that it had pending as of the close of 2017. This represents only 14.3 months of outstanding inventory, which is a substantial improvement over the 17.6-month average in 2016, many times the average in 2011, and just shy of the one-year backlog requirement newly imposed by Congress for 2018. Continue Reading 2017 Was a Banner Year for DCAA – What Does this Mean for You?

The Department of Defense (“DoD”) recently issued a final rule regarding contractor disclosures of defective pricing issues on DoD contracts, which can arise where the contractor’s certified cost or pricing data is inaccurate, incomplete or is not current. In such cases, these errors and omissions can result in significant contract overpayments by the government. While the new rule incentivizes contractors to voluntarily disclose defective pricing matters, the rule’s impact may be somewhat muted by contractors’ existing mandatory disclosure obligations under the Federal Acquisition Regulation (‘FAR”).

On May 4, 2018, DoD issued Defense Federal Acquisition Regulation Supplement (“DFARS”) 215.407-1(c)(i), Defective certified cost or pricing data. The new rule, which can be found here, provides that, when in receipt of a contractor’s voluntary disclosure of a defective pricing matter, the contracting officer will discuss the level of involvement needed from the Defense Contract Audit Agency (“DCAA”) in reviewing the disclosure, which can range from a technical review of discrete cost elements, to a limited scope audit, or the requirement for a full scope audit of the contractor. The contracting officer is, at a minimum required to discuss with DCAA:

The completeness of the contractor’s voluntary disclosure on the affected contract;

The accuracy of the contractor’s cost impact calculation for the affected contract; and

The potential impact on existing contracts, task or deliver orders, or other proposals the contractor has submitted to the government.

In Appeal of American West Construction, LLC, the Armed Services Board of Contract Appeals considered whether the U.S. Army Corps of Engineers (Government) lost its right to claim a credit under the Changes Clause by waiving its right to insist on compliance with the contract specifications prior to insisting on such compensation. Finding the Government was fully aware of the Contractor’s use of a less expensive construction method than in the specifications, the Board found the right to claim there was a change to the contract was “dead” and no credit was owed for the work not performed.

American West was awarded a MATOC contract for design-build construction services. In August 2015, the Government awarded Delivery Order 02 (DO2) under the MATOC contract for construction of bridges over irrigation canals in El Paso, Texas. The DO2 specifications provided that the work would be performed by first building two temporary bridges over the canals so the Contractor could access the site. The Contractor, however, sought access to the construction site via a levee owned by the local water district. However, because negotiations with the water district over access to the levee were pending and the Contractor could not be sure that access would be granted, the Contractor proceeded under the assumption the temporary bridges would still be necessary. Continue Reading You Don’t Always Get What You Pay For: Government Waives a Credit for Work Not Performed

It is common for corporations to compensate executives (and other employees) based upon stock price performance. Tax implications lend support for this practice with respect to high-paid employees, as executive compensation is only deductible up to a limit of $1 million per year, so companies are inclined to compensate executives with stock performance-based compensation because it is not subject to a deductible cap.

However, the tax benefits of stock performance based compensation lead to competing interests for government contractors with respect to allowable compensation. These contractors must be cautious with stock performance based compensation because the Federal Acquisition Regulation (FAR) puts several restrictions on what is allowable compensation. The restriction that most frequently comes up is the FAR’s own cap on allowable compensation ($487,000 as of 2014 and adjusted for inflation annually). However, unlike the tax code which treats stock performance based compensation favorably, FAR 31.205-6(i) deems compensation based upon stock performance strictly an unallowable cost, stating in part: “Any compensation which is calculated, or valued, based on changes in the price of corporate securities is unallowable.”

The rationale for deeming stock performance based compensation an unallowable cost has largely been based on the view that compensation is to be based on the employees’ performance, and compensation based on stock prices is not sufficiently related to work actually performed. A further concern that has been raised is the possibility of short term stock price manipulation by managers.

While these compensation restrictions are not a new development (the FAR provision was first implemented in 1983 and is frequently revised), companies sometimes seek to find ways to indirectly incorporate stock performance into compensation in a way that would deem such compensation allowable under FAR, presumably to allow for the best of both worlds under both tax code and FAR. For example, in one recent ASBCA decision, the Board wholly rejected the contractor’s argument that because (a) the pool of cash available to the employees was set separately from its stock price, and (b) the formula for calculating compensation was based upon performance relative to its peers, and not on the contractor’s stock price alone, FAR 31.205-6(i) was not applicable.

The takeaway from this recent decision is that the interpretation of this FAR provision continues to be strictly construed, and if contractors with cost reimbursement contracts (and in some cases fixed price contracts that are sole sourced) intend to maximize the amount of allowable compensation to employees, they must balance both the FAR cost caps, and the structure of the compensation packages, avoiding stock performance based compensation entirely.

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